June 2013 Archive for Know Your Market

‘Producers who fail to keep up with financial risk management tools and trends may cease to be able to compete with those who do.’

By Patrick Patton, Stewart-Peterson Inc.

At a 2010 tech conference, Steve Jobs declared that we are entering the "post-PC era."

Some thought he was crazy because they couldn’t imagine a world without personal computers. Others thought he was prophetic. Which is it? This year, PC shipments are expected to decrease almost 8 percent, replaced in large part by mobile gadgets.

Some point out that mobile devices like tablets and phones lack the computing power to do all the things a computer can do. Those in this camp say tablets are a fad.

Whether the future is in tablets, PCs or some other combination, there is no getting around one simple truth: the mobility of society. Tech companies have had to take this into account as they transform their product lines and businesses. Those who can’t find a way to transform will fall behind or fade away. (Think of companies like Intel, whose bread-and-butter is selling chips for PCs.)

There is an almost parallel evolution going on in agriculture when it comes to financial management. In a white paper recently published by BMO Harris Bank, Director of Agriculture Banking Sam Miller says, "The agriculture industry is becoming more educated and sophisticated in terms of price risk management. Those who actively implement risk management strategies to minimize costs are the ones most likely to see improvement in margin security. Perhaps more significant, however, is that producers who fail to keep up with financial risk management tools and trends may cease to be able to compete with those who do."

Unfortunately, there are some producers who see risk management as a fad. They believe volatility will ease and there is no need to learn the tools and strategies that help a business manage through volatility. I can understand that sentiment, and yet I invite you to consider this: We live in a post-predictable world.

There is always something going on that fuels volatility, whether it is global economic news, weather news, or political news. Last summer, prices were driven by the drought. This spring, we saw the effects of a drought in New Zealand – the worst that country has had in 30 years. Now we are seeing prices come off the April highs, and rest assured plenty of other things are out there than can continue to make them move – in either direction:
• Will demand hold?
• Milk production domestically is up and we are adding to cheese ending stocks. Will this drive down price?
• Will planting delays make feed hard to come by and drive prices up?

Producers need to prepare themselves for the possibilities. With how quickly we share information these days (thanks in part to all the mobile devices out there!), we will continue to see price swings as people share and digest information. And, given that the farm bill was being defeated in the House as this column was being written, we can’t rely on a government program passing anytime soon to change the pricing landscape.

Just like you can’t put the brakes on tech consumers’ desire to be mobile, there is no stopping markets from continuing to be volatile. That high-speed train has left the station. (See chart below.)

Chart caption:
Volatility remains: This chart represents the percent change of the annual average All Milk Price from year to year. For example, the average All Milk price in 2001 was 17.7% higher than the average in 2000. In 2002, the average All Milk price dropped 23.6% from 2001.

Whether you are a tech company or a farm operation, innovation is what propels you through the change. Sure, you could sit on a pile of cash to ride out the ups and downs, but that’s not a long-term solution. Just ask Cisco Systems or Apple or Intel if that strategy worked for them. Innovation saved Apple, and it will likely save Intel, too. (Read about the new Haswell chip.)

In the commodity business, innovation in your financial management will be necessary for long-term survival. It doesn’t necessarily matter which kind of risk management tool you use or prefer; in fact, no one can predict which tool or tools will be the most appropriate for the coming year. What matters is that you achieve what you are trying to accomplish for your business. A good advisor would ask those questions and help you match the tools and strategies to your business needs.

My last piece of advice: If you do decide to splurge on an iPhone, don’t count on Siri to tell you when to sell milk. I’m pretty sure she’s not a licensed advisor. Just say, "Siri, call my advisor." (And hopefully I’ll hear my phone ring!)

Thanks for reading.

Patrick Patton is Director of Client Services for Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Patrick at 800-334-9779, or email him at ppatton@stewart-peterson.com.

The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. This material has been prepared by a sales or trading employee or agent of Stewart-Peterson and is, or is in the nature of, promoting the use of marketing tools, including futures and options. Any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to Stewart-Peterson. Commodity trading may not be suitable for all recipients of this report. Futures trading involves risk of loss and should be carefully considered before investing. Past performance may not be indicative of future results. Copyright 2013 Stewart-Peterson Inc. All rights reserved.

Don’t let a "woulda, coulda, shoulda" mentality set in if you’ve missed a pricing opportunity. Here’s advice on avoiding that trap.

By Chip Whalen, CIH

Forward dairy profit margins have been in retreat over the past several weeks as milk prices have come down from loftier levels back in April. Meanwhile, feed costs have largely held steady or even increased in some cases as with soybean meal.

In the bigger picture, forward margins still exist at relatively high levels from a historical perspective, although some producers may nonetheless be discouraged that current margin projections are not as strong as they once were. This can be problematic on a number of levels. A "woulda, coulda, shoulda" mentality may set in where one feels badly to have missed an opportunity. This is not only unproductive because there is nothing a producer can do about it in hindsight, but even worse it can begin to cloud future decision-making.

Many readers of this space probably identify withKatie Krupa’s recent post in discussing the emotions that come into play when making marketing decisions. To experience the feeling of having lost an opportunity stirs up emotion which can be very hazardous when facing important financial decisions for your business.

As an example, maybe you would look at the prior margin opportunity as the benchmark to now shoot for and opt to do nothing until that opportunity presents itself again. Should margins continue deteriorating and possibly go negative, you might panic and make a rash decision to stop the bleeding and contract at unfavorable levels. While some of you reading this might think they would never find themselves in that position, I can tell you that I have experienced this firsthand and it is more common than you might think.

How does one avoid this trap? Emotions can run very strong and are quite subjective – personal experiences that vary from individual to individual. One way to keep emotions in check and limit their impact on your marketing is to bring objectivity into the decision-making process. In reading through Katie’s post that I previously referenced, she mentioned making decisions based upon the financials of your business and the concept of establishing goals.

I think this is a key point that deserves more attention. We believe it is critical for a dairy to establish goals and objectives in helping to refine their decision making process, and this all starts with a clearly defined plan. What is an acceptable return for my operation? How much risk am I willing to accept in trying to achieve this return? How much capital do I have access to that can assist me with margin management strategies to protect forward profitability?

These are some of the questions that come up in drafting what we refer to as a margin management policy that clearly spells out what the goals and objectives are, and how we intend to achieve them. This does not have to be a complicated document, but serves as a roadmap for determining where we want to go and how we plan on getting there.

Just as you might plan a summer driving trip and consider all the possible roads or routes that can bring you to your destination, you might similarly lay out all of the different marketing tools at your disposal to protect both your forward feed expenses and milk revenue. This might include an array of cash market contracting alternatives such as forwards, hedge-to-arrives, basis contracts, min/max combinations, etc. It might also include derivative alternatives including exchange-traded futures and options.

What are the features of these various contracts? What are their costs and limitations? When might I choose to use one alternative over another? This is where some of those initial questions come back into play, such as how much risk I am willing to accept or how much access to capital I have to allocate to the process. A more refined approach to marketing starts to present itself when certain alternatives can be eliminated, which may not fit with my tolerance for risk or level of capitalization. What about my goals and objectives? Perhaps I can define forward profit margin levels that represent returns for my operation which are attractive based upon the investment that I have in the business. What if I could set targets that trigger alerts telling me when this level of projected profitability has been achieved in a forward time period?

I might consider in advance what types of strategies or positions I would elect to use in the market to protect my forward profitability should an opportunity present itself, such that I was ready to take action once that event occurred. What I am describing is the process of crafting this margin management policy so that the decision making becomes objective and clearly defined.

Katie also mentioned the idea of including an outside advisor in helping with these decisions. In addition to someone like herself or myself who might assist in navigating through the various contracting alternatives at your disposal, another key partner in this process is your lender. Despite what some people might think, your lender is a very important stakeholder in your business, and wants to see that your dairy is successful and profitable. Including them in the discussion of your goals and objectives and how you might use various contracting alternatives might lead to opportunities of incorporating certain tools you would not have otherwise considered.

While a margin management plan cannot promise that you will "hit the highs" on milk or "catch the lows" on feed, it can bring a lot more structure and objectivity to the decision making process. It can even become quite granular and sophisticated, spelling out what types of strategies to use on each piece of the margin, depending on what levels of historical profitability are on the table for instance, or under what circumstances those strategies may be adjusted over time.

Regardless of how simple or complex the plan is though, one major benefit of having it in place is to remove the natural emotion that comes into play when faced with making key financial decisions for your business. You put a lot of care and attention into how you care for your dairy herd and the quality of milk you produce. Similar attention should be paid to how you are securing forward profitability to continue dairying successfully into the future.

As Vice President of Education & Research at CIH, Chip Whalen is responsible for developing and conducting all of CIH’s Margin Management seminars. He is also the editor of CIH’s popular Margin Watch newsletters. Whalen can be reached at (312) 596-7755 or cwhalen@cihedging.com.

How would the program’s results have fit into your operation?

By Ron Mortensen, Dairy Gross Margin, LLC

These "Know Your Market" commentaries are usually a chance to look forward and to plan for future marketing and risk management strategies. The thought is to continue to look forward at how to make your dairy business financially sound by using several different risk management techniques. Risk management/marketing can be emotional, stressful and time consuming, yet it is a needed task.

Perhaps by looking back occasionally, a producer can become more comfortable with different marketing techniques. Therefore, this is a review of what has happened to LGM-Dairy for December, January, February and March. The analysis is for the October 2012 sales period. Because milk prices moved significantly lower in the December-March period, these policies show good payoffs for that timeframe. Also note MILC did kick in and shows payments for three of the four months.

If you purchased LGM-Dairy in October 2012 for December, January, February and March, the following table indicates the indemnity payouts. If you purchased coverage for more than these four months, the total payout will change. Remember, the indemnity payments are averaged over all of the months you purchase.

Why is this review important? It shows, most importantly, that an LGM-Dairy policy functioned as it should. It provided cash flow when margins contracted. Perhaps a policy was purchased simply because milk was near $20.00/cwt. Maybe it was purchased due to the unknowns about feed costs at that time. Or maybe it was purchased as a systematic step in a marketing plan. How would these results have fit into your operation?

Below you will find a summary of the indemnity payments for average feed inclusion. Your specific results may vary a little based on how much corn and meal you put on your policy. The data and calculations were in part derived from U of Wisconsin LMG Dairy website. You can evaluate your policy by going to http://future.aae.wisc.edu/lgm_analyzer/.

The following charts are a summary of possible policies purchased during the Oct. 26, 2012 sales period:

Ron Mortensen is principal of Dairy Gross Margin, LLC, an agency that specializes in LGM-Dairy products and owner of Advantage Agricultural Strategies, Ltd., a commodity trading advisor. Contact him at ron@dairygrossmargin.com or visit www.dairygrossmargin.com.

Tips to help make risk management decisions and implement a plan that will work for your dairy.

By Katie Krupa, Rice Dairy

When it comes to making risk management decisions, many producers struggle with the decision-making process. Risk management can often be emotional, the information can be overwhelming and, simply put, producers don’t want to miss out on potential higher prices. The volatility has many producers asking themselves if risk management is right for them, but they still struggle with the process.

Below are a couple of tips and tactics to help make risk management decisions and implement a plan that will work for your business.

Emotion

I often find the emotional aspect of risk management is the hardest hurdle to overcome. Because the dairy is a huge part of their life, many producers are emotional when they have to make important financial decisions for their dairy. Is this the right decision for the business? Will this help financially? Will this help reduce stress, or increase stress? Will the other mangers of the business be happy? These are just some of the questions producers wrestle when reviewing their risk management opportunities.

Firstly, these emotions are normal and healthy. You care about your business and you want to make sure you are doing the right thing for your future. Secondly, don’t struggle with this alone. Bring in an outside advisor/consultant to help guide you through the process and keep you on track to making a good financial decision. Be sure to discuss your goals and strategies with the full management team rather than make the decision alone. And lastly, make your decisions based on the financials for your business; try to eliminate emotions such as fear and greed from the process.

Don’t want to miss opportunity

No one wants to miss out on any income potential, but we have to weigh the risks and the rewards. Dairy farming is naturally a high-risk business not for the faint of heart, so removing some of the risk may seem unnatural. But with the increased price volatility, many producers are finding that risk management is a vital survival tool for their business. While I certainly don’t know what the future will bring, I can almost guarantee that if you utilize risk management tools on a consistent basis, you will miss out on some of the market’s upside potential.

The good news is that, with the many diverse risk management tools available to producers, your missed upside opportunity may be minimal, and you are still protecting against the downside if prices should decline. The risk you are protecting should outweigh the reward you are potentially giving up. But figuring that out can often be emotional, so don’t struggle with that decision alone.

Not comfortable enough with all the available strategies and market insight

In recent years, the number of risk management strategies available to producers has grown significantly. While this is ultimately a good thing, it can be overwhelming to producers who do not have a substantial amount of time to dedicate to risk management. I am seeing more and more producers outsourcing their risk management needs to an experienced broker, consultant or advisor.

At first, I was very surprised by the producer’s desire to hand over the responsibilities, but after working with several dairies, I have found that the producer is more satisfied knowing that the risk management plan was created and executed based on financials of the business rather than emotion. Your broker/consultant/advisor should be making the risk management decisions based on your farm financials, upcoming needs (such as expansion), and even taking into consideration your personality. Having a third party execute the strategy removes the emotion of the farm and allows the decision to be based on numbers rather than feelings.

No one ever wants to hear "I told you so," especially when you are telling it to yourself. If you are currently sitting on the fence not sure if risk management is right for you, get off the fence and get some guidance from a professional. Getting the process started will help you make decisions down the road, and will calm that uneasy feeling you may currently have.

Katie Krupa is a broker with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. You can reach Katie at klk@ricedairy.com.Visit www.ricedairy.com. There is risk of loss trading commodity futures and options. Past results are not indicative of future results.